Individual and Market Demand 6

Income and Substitution Effects-Normal Good Clothing (units per month) The income effect, EF2, (D to B) keeps relative prices constant but increases purchasing power. R A C1 D C2 B Substitution Effect O F1 Total Effect U2 U1 E S F2 T Income Effect Food (units per month) Income and Substitution Effects-Inferior Good Clothing (units per month) Originally, the consumer is at A on budget line RS. R A U1 O F1 S Food (units per month) Income and Substitution Effects-Inferior Good Clothing (units per month) The substitution effect,F1E, (from points AD), changes the relative prices but keeps real income constant. R A D Substitution Effect O F1 U1 E S T Food (units per month) Income and Substitution Effects-Inferior Good Clothing (units per month) Since food is an inferior good, the income effect is negative. However, the substitution effect is larger than the income effect. R A B U2 D Substitution Effect O F1 U1 E S F2 Total Effect Income Effect T Food (units per month) Income and Substitution Effects  A Special Case--The Giffen Good • The income effect may theoretically be large enough to cause the demand curve for a good to slope upward. • This rarely occurs and is of little practical interest. Market Demand  From Individual to Market Demand • Market demand curves are the horizontal summation of the individuals’ demand curves. Determining the Market Demand Curve Price Individual A ($) (units) Individual B (units) Individual C (units) Market (units) 1 6 10 16 32 2 4 8 13 25 3 2 6 10 18 4 0 4 7 11 5 0 2 4 6 Summing to Obtain a Market Demand Curve Price 5 The market demand curve is obtained by summing the consumer’s demand curves 4 3 2 1 D A 0 5 10 15 20 25 30 Quantity Summing to Obtain a Market Demand Curve Price 5 The market demand curve is obtained by summing the consumer’s demand curves 4 3 2 1 D DB A 0 5 10 15 20 25 30 Quantity Summing to Obtain a Market Demand Curve Price 5 The market demand curve is obtained by summing the consumer’s demand curves 4 3 2 1 D DB D A 0 5 C 10 15 20 25 30 Quantity